News from DNB Markets

(23.06.2011)
Norges Bank kept its key interest rate on hold yesterday, but signalled that the next rate hike could come as early as in August. Hence, the Norwegian currency strengthened. The Federal Reserve also kept their key policy rate unchanged yesterday, and gave no indications of further policy stimulus.

By Anders Grøn Kjelsrud, Analyst at DNB Markets

Norges Bank decided to keep the monetary policy rate unchanged at 2.25 per cent at yesterday’s rate meeting, as widely expected. However, the new rate path, published in the central bank’s new Monetary Report, was probably a touch more aggressive than most had expected. And hence, the Norwegian currency gained in FX. EURNOK is currently traded around 7.81, versus 7.9 yesterday morning.

In short the Executive Board kept the old rate path from March, expect that the first rate hikes are hasten somewhat. The way we interpret the new path, it indicates a high probability for a rate increase at the next meeting, which is in August, and one or two hikes in the next two meetings. By the end of next year, the policy rate will have increased up to around 4 per cent.

Even though the new path on aggregate was kept roughly unchanged, two factors worked in confliction directions. On the one hand, the development in the Norwegian economy has been somewhat stronger than Norges Bank expected in March. The tightness in the labour market seems more pronounced, capacity utilization has risen to a normal level, while price and wage growth is accelerating.

These factors suggest that the interest rates should be raised more rapidly than previously thought. On the other hand, interest rate expectations abroad have fell quite significantly since the last Monetary Policy Report. The Norwegian currency has also developed stronger than the central bank projected in March, which suggests a more gradual approach. But the Executive Board's overall assessment suggested that these two conflicting conditions are roughly equal in magnitude, and hence, the rate path were kept unchanged.

Not surprisingly, the Federal Reserve (Fed) also kept its key rate on hold yesterday, close to zero. But in contrast to Norges Bank, there is nothing that suggests that the Fed will begin tightening soon. The central bank still signals that the interest rates will be kept “exceptionally low for an extended period”. Some have speculated that the central bank would go further, in terms of hinting of a fresh round of quantitative easing (QE3).

At the post-meeting press conference, Governor Bernanke explained that such a move is not very likely in today’s environment. When he started talking about quantitative easing last August (QE2), deflation was a serious threat. This danger is no longer very pronounced, as core inflation seems to be on the rise. In addition, Bernanke pointed out that payrolls growth has, after all, been stronger in recent months than it was last summer. Thus, the Fed is now much closer to fulfil their dual mandate than they were last August. The Fed will still continue to reinvest the principal payments from its maturing securities, as expected.

The FOMC did quite significant downward revisions in their economic forecasts. GDP growth in 2011 is now expected to be in the range 2.7 to 2.9 per cent, versus 3.1 to 3.3 per cent in April. The improvement in the labour market was described by Bernanke as "frustratingly slow". According to Bernanke, some of the slowdown is caused by temporary factors, such as supply problems from Japan, high energy prices and a cold winter, but he also admitted that some of the slowdown could be due to more long-lived factors. In all, we still do not expect any rate hikes from the Fed until next summer.

The market reactions after the Fed meeting were relatively muted, at least in the Treasury market. Stock prices fell somewhat, however, while the USD strengthened versus the euro in FX.